Economy could face ‘significant’ hit: RBA

A senior Reserve Bank of Australia official has warned there could be a “significant" hit to the economy from Europe’s sovereign debt crisis.

RBA deputy governor Ric Battellino said although the direct exposure of local banks and exporters to the euro area was small, the country was already being buffeted by higher global funding costs and might be hurt by a downturn in demand from its major Asian trading partners.

In his first public appearance since his retirement from the RBA was announced last week, Mr Battellino told the Australasian Finance and Banking Conference in Sydney while it was possible there would be a “relatively benign" solution to Europe’s debt woes, the risk that it could result in inflation, deflation or the break-up of the euro area “cannot be ruled out at this stage".

“While the direct exposure of Australia to a slowing in European demand is low, the indirect exposure, through the effect on some of our important trading partners, could be significant.

“It would be prudent to assume that, if the European economy were to slow markedly over the next year or so, Australia would be affected, particularly through indirect trade exposures."

Mr Battellino said in any such downturn, the economy would be cushioned to some extent by a likely devaluation in the currency.

The RBA warned that any resolution of Europe’s debt crisis would probably involve substantial help from countries outside the euro area, as well as the intervention of the European Central Bank – something that has been strenuously resisted so far.

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“It is highly likely that part of the solution will involve substantial financial assistance from outside the region or the purchase of sovereign debt by the ECB, or some combination of both," he said.

While warning that the country could not avoid the international economic fallout from Europe’s descent into debt crisis, Mr Battellino sought to buttress local sentiment, arguing that the local economy was in a good position to endure global ructions.

“Australia, like other countries, will be affected by the events in Europe, but its strong government finances, healthy banking sector and relatively limited direct trade and financial exposures to Europe make it one of the countries best placed to weather the situation," he said.